A reader of Mike Norman's very useful blog calls my last post a vacuous response to Ramanan. Of course it was not a response at all, merely a commentary. Notice how I said that "all the criticisms can be defended in two words: endogenous money!", not that they were defended... Plus I thought it implicit that whenever one says something like "I got n words for you: word_1 ... word_n", one's tongue is firmly in one's cheek. But I'm quickly learning that there is no such thing in the econo-blogosphere.
In any event, after the avalanche of comments on Mike's re-posts (last count: 21 on the post above, 66 on Ramanan's second take down, and 124 on its predecessor), perhaps it's time for a point-by-point reply (I originally called it a "point-by-pint" reply, which is perhaps a measure of what was on my mind while I was writing it).
Let me start by saying that I'll refer mostly to this paper, since I had something to do with the notation and ideas presented in it, rather than to Steve's presentation at the UMKC conference, thought I might occasionally refer to it too. Let me also say that said paper (which is being refereed and therefore can sill improve quite a lot), could use a great deal of clarifications. Many of the ideas that were in the back of our minds as we were writing it clearly didn't make it to the printed page, so I welcome the opportunity to elaborate.
With these in mind, here are the essential points:
(1) Our "closed" economy does consist of firms, households, and banks, but we find it useful to separate the banking sector from the rest of the private sector. We do this explicitly on pages 18 to 23, but leave it implicit on page 15, which contains the passages that Ramanan has a beef with. So our "change in debt" is really change in debt of the non-bank private sector to the banking sector, which obviously does not need to cancel out in the aggregate (i.e excluding banks). This is in contrast with the view that "one person's asset is another person's liability", which underlines the view that firm's debt is mirrored by household's savings.
(2) Debt only matter after it has been spent. This is the point of equation (1.5): we assume that investment is financed by retained earnings plus change in debt. If new debt is not spent, it doesn't finance anything, so we don't count it in the model.
(3) Accounting rules! The whole point of the Appendix in the paper is to show that recorded income equals recorded expenditure at the end of a given period (say one year). We don't use continuous mathematics to upset accounting identities, but rather as "a simple way to represent the conceptual difference between spending plans and current received income".
Observe that all 3 points are intimately connected with the idea of endogenous money, which is what I meant by my "two words" zinger. The effects of endogenous money only become apparent when banks are disaggregated from the rest of the private sector (1), capitalists finance new investment above and beyond savings by creating deposits through endogenous money (2), and spending plans exceed current received income for the same reason, even if this is not apparent when one measures recorded income and recorded expenditure (3).
In the end, what we are tying to capture is the idea expressed on page 10, namely that "the essence of endogenous money hypothesis is that banks create spending power for borrowers without reducing the spending power of savers."
Judging by the criticism, we haven't quite succeeded yet, but we'll keep on trying.